Notes from the Trading Desk – Europe

The Digest

Last week, global equities suffered their worst week since the global financial crisis over a decade ago, as concerns over the economic impact of the spread of the coronavirus dampened investor sentiment. The hefty risk-off move came at a time when global equities were trading near new all-time highs. The focus for markets was firmly on the virus, the economic impact and the potential for any central bank or government support.

Markets Plunge on Coronavirus Fears

A brutal week for global equities markets saw a sharp plunge lower on fears over the spread of coronavirus. Meaningful buying was short-lived. The moves were extreme in stock indices across the United States and Europe in particular: S&P 500 Index -11.5%; STOXX Europe 600 -12%; FTSE 100 -11%; FTSE MIB -11%; SMI -11%; CAC40 -12%; DAX -12%.¹

The FTSE All-World Index declined 13%, wiping out six months of performance, and US$6 trillion was lost in terms of market capitalisation.²

As one might expect, perceived “safe haven” assets saw huge inflows, with the US 10-year Treasury yield falling below 1.2% on Friday. The move did feel like capitulation, as investors de-risked ahead of the weekend and month-end.

Although defensive sectors fared slightly better than the broader market (albeit still down), overall the selloff did feel indiscriminate and broad-based. That said, it was interesting to see European value stocks generally pull out a positive performance last week. It comes as no surprise that trading volumes overall were huge, significantly above the norm.

Corporate credit markets also saw signs of strain in both the United States and in Europe.

Where Next?

As we observe this latest equity correction, there is naturally a lot of debate about where markets might go next. At the risk of stating the obvious, what makes it harder is that no one is entirely sure what to price into the market, and there is a lively debate around whether the markets could see a V-shaped or U-shaped recovery this week. Some observers have noted that market corrections are not necessarily predictors of recessions, so this latest downturn doesn’t mean the global economy is primed for a downturn.

“Whatever It Takes”

Quoting former European Central Bank (ECB) President Mario Draghi in regards to saving the euro in 2012, there is currently hope of a “whatever it takes” style moment from global central banks. However, questions remain over the effectiveness of central bank action to combat a pandemic-led slowdown, with government fiscal stimulus seen as far more effective. So far, we have these comments in Europe:

• ECB: President Christine Lagarde said the ECB is monitoring the situation “very carefully,” but insists that the bank’s base-case scenarios are “based at the moment on containment in reasonably short order.” On analysis of whether there would be any long-lasting impact on supply and demand, Lagarde insisted the bank is “certainly not at that point yet”.
• Bank of Japan (BOJ): In Japan, the BOJ said it will “monitor developments carefully, and strive to stabilise markets and offer sufficient liquidity via market operations and asset purchase”.
• Federal Reserve (Fed): On Friday, Fed Chair Jerome Powell said the Fed was considering cutting rates due to “evolving risks”. The market now sees a rate cut on March 18 as a near certainty, and Fed funds futures now see the central bank’s benchmark interest rate 100 basis points (bsp) lower by Jan 2021.³
• Bundesbank: President Jens Weidmann said that he is “expecting this risk (coronavirus) to actually materialise to a degree” and that whilst we “are confronted with a combination of a supply and demand shock… monetary policy is already quite accommodative, liquidity is abundant, (and) interest rates are already quite low”.
• Bank of England (BOE): BOE Governor Mark Carney said there’s less tourism and that supply chains for companies “are getting a little tight”. The bank has already seen drop in activity, though it’s too early to tell how badly the United Kingdom would be affected.
• Italy: The government is moving forward with extraordinary measures directed at helping household and small-to-medium enterprises. The government said it will inject EUR€3.6bn into the economy through a wide-ranging package of measures.

Corporate Commentary on the Virus

It’s the tail end of earnings season in Europe and we’re seeing an increasing number of companies offer cautious commentary around the unknown future impact of the coronavirus on earnings. Even those companies reporting solid results have struggled to make headway in the global selloff. In addition to those already scheduled to give a market update, we are increasingly seeing other companies report their concerns. For example, early in the week, Lufthansa mentioned potential cost cutting (hiring freeze, offering unpaid leave) after saying that the cancellation of flights to China was detrimental.

Other airlines have followed suit, with International Airlines Group and easyJet both reporting substantial knocks to demand, announcing measures including aircraft redeployment and hiring freezes. KLM is delaying investment in IT and real estate. The travel and leisure sector unsurprisingly has been the worst hit sector in the STOXX Europe 600.

As we kicked of the first trading day of March, the markets seemed to pause for breath after news of stimulus from Italy and the BOJ. Sentiment remains extremely brittle, however. There does not feel like there is much conviction behind the calmer start to the week here in Europe.

The Week in Review

United States

US equities suffered a torrid week as all the prior buying euphoria which had led US stock to new all-time highs this year evaporated. The spread of the coronavirus and the threat that the World Health Organization was considering a “pandemic” tag gripped investor sentiment and led US equities to their biggest weekly declines since the global financial crisis of 2008-2009. Every sector saw significant moves lower; however, there was a defensive tone to moves. Amongst sectors, communication services was the relative outperformer, falling a bit less than the overall market, followed by consumer staples.

Financials and materials fared the worst, as investors fretted about near-term economic growth. Note, Friday saw the largest ever dollar value traded on the S&P 500, so moves were pronounced on very good volume. Meanwhile, the US Treasury 10-year yield has hit record lows as investors flocked to fixed income assets. It was a quiet week in terms of macro data releases in the United States.

US Democratic Primaries

Outside of coronavirus fears, there was very little macro news. The South Carolina Democratic primary took place over the weekend, with Joe Biden seeing an upsurge in support. He took the victory and now replaces Mike Bloomberg as the favourite candidate amongst the more moderates. We also saw Pete Buttigieg (also a moderate) drop out of the race. Whilst Biden’s newfound support is impressive, Bernie Sanders remains favourite to become the Democratic candidate in the presidential election in November.

Looking ahead, it is “Super Tuesday” on 3 March, when 24 states will hold primary elections. If Sanders solidifies his support, then this could weigh on technology, energy, financials and health care stocks in the United States.

Europe

As discussed, European equities suffered one of their worst weeks in years amid the global coronavirus-driven selloff. The STOXX Europe 600 lost more than 12% last week, with all major regional indices down at least 11%.⁴

Brexit: Trade Negotiations Begin

There was plenty of noise ahead of Brexit trade negotiations, which kick off this week between the European Union (EU) and the United Kingdom. However, some of the impact was lost given the focus on the coronavirus. The pound lost 1.1% last week as both sides hardened their stance.

UK Prime Minister Boris Johnson has made it clear that the notion of “taking back control” was a red line in negotiations, warning that he is prepared to walk away from trade talks if Brussels insists on a deal that jeopardises the United Kingdom’s ability to set its own rules. He reiterated this towards the end of last week within Britain’s mandate for trade talks with the EU, threatening to walk away if talks had not progressed by June to instead focus on preparations for a no-deal exit on World Trade Organisation terms.

Alongside this, the EU finalised its own draft mandate for negotiations. Within the mandate, the EU insists that in order to get a tariff-free trade deal, the United Kingdom must agree to maintain a “level playing field” with the EU in areas including state-aid, environmental protection, and labour laws.

Johnson’s allies said that he would not accept such demands at a regulatory level. The EU seems to feel that the United Kingdom is going back on commitments made last October around this issue, whilst Johnson claims instead that the EU has violated its commitment by pushing things further than agreed in October.

Even at this early stage, the tense and difficult nature of negotiations is apparent. Johnson stuck with the stance that a Canada-style deal was the government’s preference, but the EU’s chief negotiator suggested firmly that this was not on the table. The Canada-style agreement would remove tariffs and quota, but still involve friction at the border.

In addition, the EU is now in the process of working out the details of a new seven-year budget. As these negotiations progress, it will be very apparent that there is less money in the pot following the United Kingdom’s departure.

German Politics

The German political situation has been shaken up as Hamburg citizens recently took to the polls. We expected to see more discussion around this and market impact, but with investor focus elsewhere, it was fairly quiet. The Christian Democratic Union got the lowest number of votes in what was a post-WWII low, which will have now accelerated the process to find a new party leader.

EU Macro Data Improves

Again, it was mostly lost in the noise, but we did see an improvement in EU macro data. The German consumer price index came in better than expected at 1.7%, vs. 1.6% previously. The Spanish reading was also better than expected, and French data was in line with expectations, giving some hope that the impact of the virus has been limited so far. The German IFO business climate data also came in stronger than expected, and French manufacturing and consumer confidence both beat expectations.

This week we get the eurozone inflation reading and full Purchasing Manager Index (PMI) reports, which will be in focus for many.

Syria

It’s worth highlighting the escalating crisis in Syria as another danger for European sentiment/markets. Overnight on Thursday, Russian-baked Syrian forces killed 33 Turkish soldiers. If Turkey steps back from defending the last rebel enclave, we could face another refugee crisis in Europe that would put huge strain on the EU.

Another refugee crisis would be extremely destabilising and could further fuel the rise of populism across the continent. Over the weekend, we saw further escalation of the conflict, and Turkish President Recep Tayyip Erdogan is expected to meet Russian President Vladimir Putin next week, despite strained relations.

Asia and Pacific

Asian equities outperformed on a relative basis to other markets last week, but still experienced broad weakness amid the spread of the coronavirus from the region. Anticipated central bank stimulus and new government policies to battle the spread of the virus seemed to help support markets somewhat. Sector moves were very similar in nature to Europe and the United States, with communication services and utilities the relative outperformers (albeit still down) whilst energy was the notable laggard, down 11% on the week.

Weak Macro Picture

Macro data out of the region has been awful of late, as the true impact of the coronavirus outbreak becomes apparent. Over the weekend, China released its latest PMI results, with the February Composite PMI coming in at 28.9 (vs 53 previous). The significant drop was attributed to a shortage in labour and supply chain disruption. With the population still contained within region as the government fights any further spread, it’s likely that the sizeable downturn in economic performance in China will continue.

Data out of Hong Kong continues to be abysmal, too. Retail sales in January were down, whilst export and import data from last week was also particularly poor. Finally, Hong Kong’s gross domestic product contracted 2.9% on in the fourth quarter on a year-over-year basis. That means the Hong Kong economy contracted for three of the four quarters last year.

The Week Ahead

Politics

• Trade negotiations between the EU and United Kingdom officially begin. We can expect the pound to come under further pressure should tensions continue.
• In the United States we have “Super Tuesday”, with 14 states holding primaries for the Democratic nomination. Up for grabs are 1,357, or 34%, of the delegates to the Democratic convention.
• The situation in Syria continues to escalate and could have far-reaching consequences.

Key economic data

• Monday: Manufacturing PMIs from the Eurozone (Germany, Italy, France, UK); US Manufacturing PMI; Japan PMI and ISM Manufacturing; China Caixan PMI Manufacturing
• Tuesday: Eurozone Inflation data; , Japan consumer confidence on Tuesday
• Wednesday: Europe Services PMIs; US composite PMI, and ISM non-manufacturing; Japan services PMI and China Caixan Services PMI
• Thursday: German construction PMI; US Factory orders; Australia Trade Balance
• Friday: Trade balance and nonfarm payrolls; Japan household spending and Australia retail sales
• OPEC+ meet on Thursday and Friday in Vienna. It could extend or deepen oil production cuts in response to the outbreak of the coronavirus.

Monetary Policy

• The central bank response to coronavirus will be key as central banks and governments are expected to continue to pledge their support to stem the economic impact. The Fed is due to meet on the 18^th of March, but some analysts have raised the possibility of a surprise interest rate cut this week as part of a coordinated campaign of easing aiming to combat the Covid-19-driven slowdown.

Over the weekend the BOJ joined the Fed in issuing a rare statement assuring that “appropriate” actions will be taken and offered to lend 500 billion yen to financial firms.

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1. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.

2. Source: Reuters, “Going Viral: Six Charts and the $6 Trillion Loss” 28 February 2020.

3. Source: CME Group Federal funds futures. A basis point is a unit of measurement. One basis point is equal to 0.01%.

4. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.